Renewed China growth anxiety fuels bear market jitters.

Current Overview

Investors and traders have returned to the worst start to a year for equity markets for as long as one can realistically recall. A further China currency devaluation in early January has exacerbated the ongoing commodity price rout which is driving the resource heavy FTSE 100 lower. Of additional concern is the emerging possibility that China’s issues will drive the global economy into recession and deflation. In an almost bizarre and quickly changing market dynamic, forecasts for interest rate rises are now being pushed further into the future and investors are naturally uncertain with markets moving lower in sympathy. Over the past few days, some of the day to day volatility has been staggering. Whether we are seeing (again) a pullback (or correction) in an ongoing uptrending market (as in August last year) or the progression of what could be an extended bear market, frankly only time will tell. As I write, I would suggest that markets are holding onto key technical (chart low) support levels (the levels hit last summer when China first devalued their currency) and it is very important that we see little further deterioration. There is a big gap lower on the FTSE 100 chart if it closed below say 5700.

Only two months ago the US market was pleading for a rate rise (it got one), such was the confidence in their outlook. A UK rate rise was considered to be not far behind. Now rate rises in the UK are not forecast until next year (!) and the US Fed has turned more dovish as a result of recent financial market downside and economic growth anxiety. It is amazing how quickly sentiment and the macroeconomic prognosis can be turned upside down. There is also a mounting disillusionment amongst market professionals with the foresight and cognition of anglo american central bank policy. It is possible that raising rates (in the case of the US) was premature with hindsight. On the other hand, it could be argued that despite heavy stock market falls, central banks need to remain focused only on what they are strictly remitted to focus on. In the main, this would be inflation and unemployment statistics. In terms of inflation, lower oil has probably largely removed risk for now but transatlantic unemployment is at multi year lows. Some would thus say that the Federal Reserve (at least) may need to keep incrementally increasing rates. Difficult and unpredictable times persist but central banks cannot be held responsible for volatility (weakness) in markets. Readers may recall Alan Greenspan’s (former Fed chief) famous “irrational exuberance” comments when looking at excessive stock market valuations in the 1990’s. The US market until its recent 15% slide was trading at a punchy valuation.

Reflecting back on 2015, who could have predicted the Black Friday sell off (China devaluation event) and oil at under $30 per barrel at the beginning of the year. Answer, no-one frankly and in the end it was a difficult year with few stocks recording gains. Certainly the board of directors at Shell did not when they tabled a takeover offer for BG last Easter. That said, I believe we are now or have recently been at (near) once in a lifetime investment levels for selective companies in the resources space. Oil has actually rallied 30% from its recent low and with talk of an OPEC supply cut and a falling dollar, this sector could be heading higher.

Finally, the impending referendum on the UK’s membership in the EU is also understandably weighing on investor’s minds. The general view is that leaving the EU would be an economic mistake on balance, forcing interest rates higher for example when the economy would least need them. Personally I believe we will remain in Europe once improved terms our secured. I also suspect the market is overly anxious regarding China and its potential hard landing.

The stock market is not currently complacent and this is a positive. Over confident, blue sky markets, investors need to be most wary of in my view. Currently, investors are worried and multi risk factor aware and the market is discounting these risks. While the declines are naturally a concern for clients who have seen their valuations impacted, these for me are markets to hold and selective acquire. To be convinced significant further falls are coming is a big call. A call which could be costly if one liquidated the portfolio and further falls never really materialise. Trying to time such eventualities would be nothing other than a fluke and it is far wiser to simply ride out unpredictable times. Bear markets do not run for as long as bull markets and even if 2016 proves to be another tough 12 months, there are always selective opportunities to seek out ahead of improved times.

Stock specific comment

Defensive sectors such as telecom, tobacco and pharmaceutical have traded impressively over the past few years relative to other areas of the market. Resources companies and financials for example have traded poorly. In some ways, the market has thus been quite binary: a few groups have fared well and few badly. Most investors hold (sensibly) diverse portfolios and thus will likely be holding a mixture of different companies; this risk manages (to an extent) different levels of stock specific risk and smooths overall performance. As a rule of thumb, such a strategy should always be employed.

In terms of how investor’s may tackle 2016, it depends on numerous factors starting with attitudes to risk. Financial and resources companies could have significant upside potential from current levels. Defensive names (which have performed well for an extended period) could therefore be set for a muted 2016. Diversified strategies involving investing in collectives (such as investment trusts) are suitable for many and give options to invest directly into other geographic regions.

Equities longer term have always delivered over other asset classes and while we may see a continuation in the trend of companies reducing dividends this year, payouts will still be attractive, certainly to buyers of shares at current levels.